LATIN AMERICAN STOCKS DECLINE SLIGHTLY IN DECEMBER ALONG WITH MOST MARKETS INCA Investments, LLC (January 2012) The Latin American markets, as measured by the MSCI Latin American Index in U.S. dollars, declined 1.6% in December. Most of the world s key equity markets declined during the month, although the U.S. S&P500 was an exception - it rose 0.9%. The MSCI Europe Index declined 1.6% on lingering concerns about the European sovereign debt crisis while the overall MSCI Emerging Markets Index fell 1.2%. For the full year of 2011, Latin America declined 19.4%, roughly in line with the overall Emerging Markets Index which fell 18.4%. Both of these developing world indices underperformed the U.S. and Europe for the year, with the U.S. S&P500 ending the year unchanged while the MSCI Europe fell 11.1%. Most of Latin America s country indices fell during the month of December led by Mexico and Brazil which declined 2.1% and 2.0%, respectively. In the case of these two countries, the monthly depreciation of the Mexican peso (-2.3%) and the Brazilian real (-3.1%) in relation to the U.S. dollar accounted for the entire decline of the Mexican and Brazilian indices. The Peruvian index also declined, tracking downwards 1.8% while the Chilean index increased 0.5%. The main sector contributor to the Latin American index s decline in December was the underperformance of commodity stocks as the prices for copper, crude oil and iron ore fell. In addition, the energy and material sectors were some of the poorest performers, falling 5.9% and 4.0% respectively; while the more defensive utilities (+3.3%) and consumer staples (+1.6%) were the best performing sectors in December. Brazil, which has the region s largest equity market and economy, has been easing its benchmark interest rate since August to spur economic growth as the deterioration of the world economy has provoked a deceleration of Brazil s economic growth. The most recent rate cut came in November when the Brazilian Central Bank lowered the country s benchmark interest rate from 11.5% to 11.0%. The Brazilian government has said it will continue to use monetary policy essentially further easing of interest rates as a tool to counter the negative impact on the Brazilian economy from the global economic slowdown and to reach the government s 5% GDP growth rate target for 2012. We, along with most economists however, expect Brazilian economic growth to be somewhat less this year. MSCI LATIN AMERICA MONTHLY PERFORMANCE (in USD) Both the Brazil and Mexico indices fell exclusively due to the deprecation of the Mexican peso and the Brazilian real against the U.S. dollar. The Mexican index also declined in December in spite of a series of macroeconomic readings which showed that the country s manufacturing as well as its consumer segment continue to show resilience, in spite of the decline in economic activity in the
developed world. We believe Mexico is well placed to benefit from its strong export-led economic growth and from the continued recovery of the country s domestic consumption segment. In Peru, the nation s president Ollanta Humala reshuffled his cabinet to overcome a split which developed in his government over a proposed mining development which had drawn objections from some of his left of center cabinet members. We believe Humala s decision to increase the power of the promining investment faction in his cabinet is another indication of how he has adapted a pro-business governing style which is reassuring investors about his commitment to policies that support the continued economic growth of Peru. Elsewhere, in Chile, the government s statistics office released data which indicates domestic economic activity is moderating slightly although Chile s GDP still grew 4.4% in the past twelve months until the end of November. During the same period retail sales were up 8.5% supported by a tight labor market and strong consumer confidence which have continued to boost the country s domestic segment. It is our view that Chile still is the best managed economy in Latin America and even though the country is considerably more export oriented than most of the region, it is well prepared to respond to any further worsening of the world economic situation. CEMEX AND RANDON IN FOCUS In December, Mexico-based cement maker Cemex (which accounts for 4.3% of the WIOF Latin American Performance Fund) increased 15.1%. Cemex s shares rose due to the increase of cement prices in the U.S. and Mexico in December compared to a month earlier, which may indicate that the demand for cement may finally be improving in these countries. The deterioration of the global economic outlook, especially the slowdown of the U.S. construction sector, weighed heavily on the company s shares in 2011 and it is our view that investors have reacted positively to a potentially better outlook for cement makers, realizing that the shares may have been overly discounted. Even though Cemex is one of the world s largest and most geographically diversified cement-makers, the U.S. is its main international market outside of Mexico, and the company s prospects will directly benefit from any pickup of the U.S. market. Regardless of the future performance of the U.S. market, we believe Cemex could continue to grow its business solely from its operations in the high growth emerging markets, which make up nearly 75% of its cashflow. In the same month, Brazilian semi-truck trailer and truck parts manufacturer Randon (3.1% of the Fund) declined 16.6%. Investors sold shares in Randon in December on concerns that a recent slowdown of Brazilian industrial activity could weigh on the company s future earnings potential. More specifically, vehicle production declined 4.9% in December compared to a month earlier, although vehicle production in Brazil is still significantly stronger than a year ago; it increased 18.0% in December y-o-y. The more sluggish global economic situation is clearly having repercussions in Brazil in the form of a lower GDP growth rate and the above-mentioned slowdown in industrial activity and it is our view that a company like Randon may also face a slightly slower rate of growth in the short term. However, we believe the company is very well placed in the mid to long term to benefit from Brazil s economic growth and in particular from the country s competitive advantage in the production of agricultural goods, which are an important driver for truck usage. Randon is the largest manufacturer of semi-truck trailers in Brazil with a 33% market share and the country s largest producer of truck parts with a 50% share. Due to the benefits of scale, Randon is able to keep its costs lower than competitors and can offer better service to its customers since it is the only company in the sector with a nationwide sales and support network. Brazil is also an especially attractive market for truck manufacturers. The average truck age in the country is 18 years, compared to 12 years in Mexico and between six and eight in the U.S. and Europe. For this reason, Brazilian truck manufacturers are likely to benefit from stronger demand in coming years as vehicle fleets are replaced. We also believe that as the country s largest semi-truck trailer producer, Randon is well-positioned to continue capturing more of this future increase in demand for trucks than its smaller competitors. In our view, Randon is a very attractive holding that will continue to generate above-average growth in the future.
LATIN AMERICA UNDERPERFORMS IN 2011; ECONOMIC AND MARKET OUTLOOK FOR THIS YEAR REMAINS FAVORABLE In this month s newsletter we will review the factors which had the most significant impact on the Latin American markets in 2011 as well as analyze the economic environment and outlook of the region s main economies. The main driver of the Latin American index s 19.4% decline in 2011 was not internal, but external in the form of the European debt crisis. Sovereign debt levels in the Eurozone and their potentially negative impact on world economic growth weighed heavily on sentiment throughout the year as investors sold shares around the world. Although investors became gravely concerned with overleveraged economies, their fear is not particularly relevant to Latin America. Indeed, Latin American debt levels, both public and private, are considerably less than in the developed world and not anywhere close to the debt levels found in the overleveraged economies of Europe, as shown in the Graph A. As a part of the global economy, Latin America will be affected by a further deterioration of the global economic environment, but it is our view that Latin American economies are less vulnerable than those of the developed, and the majority of the developing world. Not only does Latin America have reasonable credit levels, it is also partially insulated from the global stresses due to the internal nature of its economies - the region is not overly dependent on external markets for economic growth. Latin America s economies are driven by domestic consumption and exports account for only 21% of the region s GDP, which is far less than Asian and Eastern European countries as well as lower than many of the mature economies of the developed world. GRAPH A: TOTAL DEBT AS A PERCENTAGE OF GDP* GRAPH B: MARKET PERFORMANCE 2011 However, the traditional investment view that emerging markets are a riskier asset class in spite of economic fundamentals which counter this long held view trumped economic reality as emerging markets, especially those in Latin America, declined more in 2011 than those in the developed world. The U.S. S&P 500 index ended the year flat while the MSCI Europe index declined 11.1% compared to the 17.4% decline for the Emerging Asia index and the 19.4% fall for the Latin American index see Graph B.
On a country level, the economic growth of Brazil, the region s largest market, decelerated in the second half of 2011 and was flat in the third quarter compared to the previous quarter. Brazil s 2011 GDP growth is now likely to be at around 3.0%, after growing 7.5% in 2010. In August of last year, the Brazilian Central Bank began lowering the nation s benchmark interest rate to stimulate economic growth. After tightening the rate from the beginning of the year until August, the Central Bank began easing the rate from its peak of 12.5% to 11.0% by the end of the year. The move to ease rates, however, could push inflation higher at a time when Brazil ended 2011 with an inflation rate of 6.5%, the upper end of its target for the year. Another concern we have about Brazil is that the nation s currency may be overvalued and that on the credit side, Brazilian consumers may be overextended. Consumer debt in Brazil, compared to other Latin American countries, Chart C. In spite of these issues in the consumer segment, both the Brazilian government and the nation s banks appear to be financially solid. The Brazilian government s debt level is relatively low and the country s central bank holds foreign reserves in excess of its foreign debt. In terms of the country s banks, financial figures from the large banks demonstrate that they are well managed, provisioned and capitalized. Although we believe Brazil may be a bit more vulnerable than some of the other Latin American countries, overall the Brazilian economy is in good shape and the country is well positioned to continue growing its middle class. The Mexican economy is still in a recovery phase following the significant economic decline during the GRAPH C: CONSUMER DEBT SERVICE (% OF DISPOSABLE INCOME) Global Credit Crisis. Both the services and manufacturing sectors are currently driving growth and have recovered from the decline of the Global Credit Crisis, as shown in Graph D. In July of 2012, Mexico will hold presidential elections. Enrique Peña Nieto from the PRI party is the frontrunner and if he wins, his party is also expected to control the congress. From an economic perspective, we believe this could be significant because it would allow the PRI to pass important reform legislation that the current administration has not been able to push through, due to the opposition party s control of congress. Peña Nieto has hinted that he is looking to reform the state owned oil company, Pemex, to allow it to partner with private companies and increase exploration activity. We believe this could be very beneficial for Mexico as it has the potential to reverse the decline in the country s oil production and set the stage for further reform in other areas the government needs to open to private enterprise to spur economic growth. These types of reforms, along with the country s strong export-led economic growth, could usher in a period of sound growth for Mexico and bode well for the country s market. GRAPH D: MEXICO S GROWTH DRIVERS (Y/Y % CHANGE)
Chile, in our view, continues to be the best-managed economy in Latin America. Chile is more export oriented than most Latin American countries, primarily due to its significant copper exports, which represent approximately 15% of the country s GDP and 42% of its exports. Although the importance of copper for Chile means it is susceptible to a potential drop in the metal s price, the Chilean government operates a rainy day sovereign wealth fund built up with proceeds from the copper industry which is equivalent to approximately 5% of the country s economy, and this fund could be used to stimulate the economy if needed. In 2011, the Chilean index fell 20.4% and the resultant lower company valuations, combined with the country s good economic prospects, make Chile a very good market for long term investment. Peru s projected GDP growth rate of 5.6% for 2012 is the highest in the Latin American investment universe. The projected GDP growth rate of Peru, which is expected to be 5.6% in 2012 according to the IMF, is the highest in the Latin American investment universe and reflects the country s strong economic prospects. In terms of the Peruvian market s performance in 2011, the country s index declined in the first half of the year over concerns that Peru s new president, Ollanta Humala, would follow policies which could be detrimental for investors. However, Humala has acted very pragmatically and it is our view he will continue to employ policies that will support the country s strong growth rates. Due to the Peruvian market s 21.4% decline in 2011 combined with our greater confidence in the country s political management, we expect to find well managed Peruvian companies trading at attractive valuations. The Colombian economy grew over 5.0% in 2011 and we expect it will continue to grow at a high rate during 2012, in large part because of the success Colombia has had at reducing the influence of violent armed groups which previously had caused significant security problems and had adversely affected the country s economic growth. This improved outlook though, along with the small size of the Colombian equity market, has pushed the country s stock prices to above-average valuations. Although it is difficult to find investment bargains in Colombia, we will continue to monitor its market closely in our search for companies that represent well-priced opportunities. During 2011 the MSCI Latin American Small Cap index declined 29.5% compared to the 19.4% decline in the regular index. In a year of significant negative performance highlighted by investor concern regarding the global economic environment, it is not surprising that smaller cap companies would underperform their large cap brethren. More surprising is the negative performance of the value stocks in a down year since the value style is generally considered to be more defensive. Out of all the style biased indices that MSCI calculates for the Latin American market, the worst performing index for 2011 was the Latin American Small Cap Value Index, which declined 31.8% for the year. The underperformance of value is not just a Latin American phenomena, it was also replicated in the US market with the S&P500 Value Index falling 2.9% in comparison to the 2.8% increase for the S&P 500 Growth Index. It should also be noted that the underperformance of value also occurred on a global basis during the horrific year of 2008. It is not apparent to us why value stocks have underperformed during the most recent negative years, which is counter to the way they have behaved historically. We speculate it is the recent behavior of global investors to view value stocks more as potential traps rather than bargains. The concern with investing in value traps, we believe can be traced to the misguided investments in beaten down banking stocks by some of the most well-known and respected value oriented investors, such as Bill Miller of Legg Mason and Bruce Berkowitz of Fairholme Capital, to name a few. To their dismay, and that of many other value investors, it turned out that the lower prices available in bank stocks were not reflective of a temporary loss of capital. Indeed it turned out that the lower prices were not bargains at all, but were reflective of a permanent loss of capital which became apparent as banks continued to report losses from non-recoverable loans. The negative environment of the Global Debt Crisis of 2008, as well as the current European Debt Crisis, has further
fostered an atmosphere where investors cannot see beyond the current economic malaise and are driven by a fear that companies which have been affected by a temporary negative event or circumstance have suffered a permanent loss in value. We believe that the value style will return to favor, as it did in the bounce back years of 2009-10, and as time reveals to investors that most good companies that suffer a stock price decline are more a victim of a change in investor perception than a change in company or industry fundamentals. Although we do not have any particular insight on when the global economic outlook will improve, we are confident that Latin American countries are in good relative standing to withstand the decline. More importantly we retain our conviction that specific stocks will rebound strongly when investor confidence in a brighter future eventually returns. We also believe that stocks such as Mexican homebuilder, GEO, and Brazilian producer of health and beauty products, Hypermarcas, which were particularly hard hit last year due to specific company and industry concerns, will perform particularly well as their strong fundamentals come to the fore in 2012. IMPORTANT NOTE: This report has been prepared for information only, and it does not represent an offer to purchase or subscribe to shares. World Investment Opportunities Funds ( WIOF ) is registered on the official list of collective investment undertakings pursuant to part I of the Luxembourg law of 20th December 2002 on collective investment undertakings as an open-ended investment company. WIOF believes that the information is correct at the date of production while obtained from carefully selected sources considered to be reliable. No warranty or representation is given to this effect and no liability can be assumed for the correctness or accuracy of the given information which may be subject to change at any time, without notice. Past performance provides neither a guarantee, nor an indication of future performance. Value of the shares and return they generate can fall as well as rise. Currency fluctuations, either up or down, may also affect value of the investment.due to continuing market volatility and exchange rate fluctuations, the performance may be subject to significant changes over a short-term period. Investors should be aware that shares in the financial instruments entail investment risks, including the possible loss of the invested capital. Performance is usually calculated on the basis of the relevant NAV unless stated otherwise. Performance shown does not take account of any fees and costs associated with subscribing or redeeming shares. It is assumed that all dividends were reinvested. WIOF prospectus is available and may be obtained through www.sfmworldfunds.com. Before investing in any WIOF Subfund(s) investors should contact their financial adviser / legal adviser / tax adviser and refer to all relevant documents relating to the WIOF and its particular Sub-fund(s), such as the latest annual report and prospectus that specify the particular risks associated with the Sub-fund, together with any specific restrictions applying, and the basis of dealing. In the event investors choose not to seek advice from a financial adviser / legal adviser / tax adviser, they should consider whether the WIOF is a suitable investment for them.